Not only do operators of virtual currency businesses face a growing body of overlapping federal regulations, but they must also contend with a patchwork of state laws as well. Compliance with state money transmitter laws, which typically provide for licensure and supervision of various non-bank financial services companies that handle cash on behalf of consumers, has become a hot-button issue for members of the crypto community. A few states, such as New York with its BitLicense regime, have developed very specific regulations for cryptocurrency businesses. Other states are silent on the issue and have not issued any specific regulations or interpretive guidance, leaving the industry to speculate as to the proper interpretation of the law in those states. Texas falls into a third category of states that have issued interpretive guidance (but not formal regulations) to apply their existing money transmitter statutes to operators of virtual currencies. Recent guidance from the Texas Department of Banking provides a thoughtful discussion of the virtual currency industry and interprets the Texas Money Services Act (the “Act”) for operators of virtual currency businesses doing business in the state.
Under an amended Supervisory Memorandum (the “Memo”) issued by the Texas Department of Banking on January 2, 2019, virtual currencies are divided into two categories under the Act: centralized virtual currencies and decentralized virtual currencies. According to the Memo, “centralized virtual currencies” are created and issued by a specified source, and rely on an entity with some form of authority or control over the currency. The Memo identifies one particular subclass of centralized virtual currencies as stablecoin. Stablecoins are a form of centralized virtual currencies that is backed by the issuer with sovereign currency, precious metals, or cryptocurrency and therefore hold intrinsic value. The Memo opines that the most popular sovereign-backed stablecoin at this time is Tether, a coin backed 1-to-1 by US Dollars so one Tether coin is the equivalent value of one USD at all times.
The Memo notes that “decentralized virtual currencies” are not created or issued by a particular person or entity, have no administrator, and have no central repository. As examples of decentralized virtual currencies, the Memo cites Bitcoin, Litecoin, Ripple, and Ethereum. The Memo uses the term “cryptocurrency” synonymously with a decentralized virtual currency. According to the Memo, one important characteristic of cryptocurrency is its lack of intrinsic value. A unit of cryptocurrency does not represent a claim on a commodity and is not convertible by law. Unlike fiat currencies, there is no governmental authority or central bank establishing its value through law or regulation. Instead, its value is only what a buyer is willing to pay for it.
The Memo then turns to how virtual currencies are treated under the Act. “Currency” under the Act is “the coin and paper money of the United States or any country that is designated as legal tender and circulates and is customarily used and accepted as a medium of exchange in the country of issuance.” Because neither centralized virtual currencies nor cryptocurrencies are coin and paper money issued by the government of a country, they cannot be considered currencies under the statute. Therefore, the Memo opines that absent a legislative change to the Act, no currency exchange license is required in Texas to conduct any type of transaction exchanging virtual with sovereign currencies.
The Memo also considers the status of virtual currency under the Act’s money transmission provisions. The Act defines “money transmission” in a way similar to other state money transmitter laws as “the receipt of money or monetary value by any means in exchange for a promise to make the money or monetary value available at a later time or different location.” The term includes:
- selling or issuing stored value or payment instruments, including checks, money orders, and traveler’s checks;
- receiving money or monetary value for transmission, including by payment instrument, wire, facsimile, electronic transfer, or ACH debit;
- providing third-party bill paying services; or
- receiving currency or an instrument payable in currency to physically transport the currency or its equivalent from one location to another by motor vehicle or other means of transportation or through the use of the mail or a shipping, courier, or other delivery service;
but excludes the provision solely of online or telecommunication services or connection services to the Internet.
In many instances, the Memo notes that the factors distinguishing the various centralized virtual currencies are complicated and nuanced, and to make money transmission licensing determinations the Department must individually analyze centralized virtual currency schemes. Accordingly, the Memo does not offer generalized guidance on the treatment of centralized virtual currencies, other than sovereign-backed stablecoins, by the Act’s money transmission provisions. Instead, money transmission licensing determinations regarding transactions with cryptocurrency and sovereign-backed stablecoins turn on the single question of whether either should be considered “money or monetary value” under the Act. The Act defines money transmission as “the receipt of money or monetary value by any means in exchange for a promise to make the money or monetary value available at a later time or different location.” In turn, under the Act “‘money’ or ‘monetary value’ means currency or a claim that can be converted into currency through a financial institution, electronic payments network, or other formal or informal payment system.” As noted above, a cryptocurrency is not currency as that word is defined in the Act. Therefore, according to the Memo, cryptocurrencies as currently implemented cannot be considered money or monetary value under the Act.
On the other hand, the Memo observes that stablecoins pegged to sovereign currency may be considered a claim that can be converted into currency and thus fall within the definition of money or monetary value under the Act. In those instances where the stablecoin is backed by a sovereign currency reserve and a redemption right exists to the holder of the stablecoin, the holder has a claim to the sovereign backing the coin because the issuer has taken on the obligation to provide sovereign currency in exchange for the stablecoin at a later time (upon the holder’s request).
The Memo concludes with a broad statement of policy. Because cryptocurrency is not money under the Act, the Memo opines that receiving it in exchange for a promise to make it available at a later time or different location is not money transmission. Consequently, absent the involvement of sovereign currency in a transaction, no money transmission can occur. However, when a cryptocurrency transaction does include sovereign currency, it may be money transmission under the Act depending on how the sovereign currency is handled.
As further examples, the Memo highlights the regulatory treatment of some common types of transactions involving cryptocurrency can be determined as follows:
- Exchange of cryptocurrency for sovereign currency between two parties is not money transmission.
- Exchange of one cryptocurrency for another cryptocurrency is not money transmission.
- Transfer of cryptocurrency by itself is not money transmission.
- Exchange of cryptocurrency for sovereign currency through a third-party exchanger is generally money transmission.
- Exchange of cryptocurrency for sovereign currency through an automated machine is usually (but not always) money transmission.
- Because a sovereign-backed stablecoin may be considered money or monetary value under the Act, receiving it in exchange for a promise to make it available at a later time or different location may be money transmission.
Of course, a virtual currency business that conducts money transmission must comply with the Act’s licensing provisions, including maintaining minimum net capital and being subject to official supervision and examination.